Somehow it's fitting that the following come from a blog entitled Autopia.

Scientists hope that by perfecting technology that squeezes oil from a stone we can greatly increase the domestic U.S. oil supply.

The Los Alamos National Laboratory and Chevron are developing technology that can improve the yield of material from shale that can be turned into crude oil. The research will be undertaken in Piceance Basin in Colorado. According to Chevron "The U.S. Geological Survey estimates the United States holds 2 trillion barrels of oil shale resources, with about 1.5 trillion barrels of those resources located in the western United States, primarily in Wyoming, Colorado and Utah."

Sorry, but we'll be running on fuel cells with electrolysis-derived hydrogen before anything will happen with shale.

Thank this National Public Radio article for discovering that people who invest in the asset we call oil causes its price to rise. The title of the article is great: "Analyst: Blame Investors for High Gas Prices". Whether speculator or oil company, we're all investors if we are long or short an asset. Even when we buy and then consume gasoline, we invest in it because it provides an benefit. That benefit (driving to the mall) is our gain. Thus, this article's title is a bit meaningless.

While this article is interesting in that it explains what trading "oil contango" is in an easy way, ite is absurd in that it implies that high oil prices are the work of "big money" and "investment banks" as if they are some sort of evil force. Please, if you have the time listen to the podcast of this article rather than reading it. Its much more funny when you can hear the tone of the reporter and the extra little asides he adds in. Classic NPR.

The steady increase in the price of oil is usually explained in a
fairly straightforward way. Fast growth in China and India has created
a market in which supply just barely matches demand. And in a market
sensitive to possible disruptions, anything from political unrest in
Nigeria to corroded pipelines in Alaska can bring a spike in prices.

That's
the typical explanation. But some in the industry think it's too
simple. They say other factors are just as important as the
relationship between demand and supply. Chief among them is "contango,"
a market term for the situation in which a commodity -- like oil -- has
a higher future value than its current price.

First, we're skeptical about this claim that there are somehow other factors completely unrelated to demand and supply which determine price... perhaps NPR needs to learn that we live in a modern financial world. Despite the many ways to get economic exposure to an asset, basic supply/demand for an asset still underpins its price. Ok, let's keep going...

Oil companies and others like to buy futures contracts to make sure
they've got oil coming to them well into the future. But lately, people
who have nothing to do with the oil industry are buying oil futures [orchestra hit- dun dun!]

This reporter seems overly shocked by the fact that speculators exist. Someone should perhaps explain that if a all the rice (or whatever) companies want to hedge their exposure to rice prices, then someone is needed to step in and fufill the other side of the contract. (that someone is called a speculator) There MUST be market players in futures markets who aren't commodity producers else you'd have some pretty strange looking futures markets. Everyone would be buying hedges and no one selling them. That would make hedging pretty expensive. More speculators means more sellers vs. buyers of commodity hedges and thus cheaper hedges for commodity producers to buy. Speculators are good! (Again, please listen to the podcast from this story's link)

Investment banks from Morgan Stanley to Goldman Sachs are making so
much money from oil futures that they've become a hot investment for
all sorts of big-money players. [another orchestra hit- dun! dun! dun!]

Uh-oh! Oil prices are high because of those darn big-money players. Its a shame, if only small money could outweigh big money in these wacky "futures markets". That'd be more fair for everyone.

Some of the biggest players are U.S. pension funds, which have put
billions of dollars into oil futures. [You must hear the reporter laugh contemptiously while saying "billions" as if this is some completely grotesque number. Newsflash- one billion dollars isn't a lot of money in economics]

At least one analyst thinks that
pension funds have become part of the machinery driving higher gas
prices. "I think if you saw all the pension funds walk
away," says Ben Dell, an oil analyst at Sanford Bernstein, "you'd
probably see a $20 drop in the crude price."

This is a case of confusing cause and effect. Oil contango means that the futures market believes that, in the future, supply of oil will be tighter than it is now relative to future demand for oil. If a riskless profitable contango trade exists it is because speculators have notsufficiently traded the current price of oil up and not sufficiently sold the future price down. See, those big money speculators are buying oil now and selling it in the future. Selling pressure on future prices pushes future prices down. As more and more speculators do this, your current oil price yes moves up, but the future price comes down.

So maybe we were ineed a bit wrong... You can blame speculators for the high future price of oil. In fact, they should be executing this contango trade more. (if indeed this riskless trade exists, which we are also suspect of since oil futures are one of the most widely watched and liquid markets in the world.)

The problem, he [an analyst] says, is that pension funds and other investors are
buying oil to remove it from the market -- which can help drive up
demand -- before selling it for a profit some months later.

Yes, they will sell it later, thus increasing future supply and pushing down the future price. And the text version leaves out some of the funniest parts here. At one point we're told that luckily investment banks are running out of places to store oil- implying that otherwise they could just run the price of gasoline through the roof for us poor folk.

We apologize for being a bit overly excited in the above paragraphs. The final comment we'll end on is that the oil contango trade as outlined in this NPR article is actually a short trade on oil, not a long trade. Its short because you lock in the future price you sell at. If oil prices go up, you miss out on profits. (should have just held the oil sans contract) Its when oil prices go down that you make out best relative to others (you get to sell at your higher, locked in price). Thus ultimately all these big money players are actually shorting oil when they execute this mysterious contango trade.

Beyond this article, we are very interested in oil contango right now, and yes we see what seems to be the opportunity for riskless gains above the risk free rate. But just can't believe its true. What we don't know yet is what the actual holding cost of oil is. Does anyone know approximately what this is? We need to complete the following problem: Which Oil Contango trade has an annualized return greater than the risk free rate + holding costs? If we had the holding costs we could see if there is indeed a riskless profit to be made. So far the best we see is an 11.7% annualized gain. You can see this contract to trade in the chart below. Hopefully the Stalwart can help close this nasty inefficiency if indeed it exists. (somehow in one of the most liquid, highly watched market in the world)

We made the chart below using data downloaded from NYMEX a few days ago.

We are facing an epic competition between the 800 million motorists who
want to protect their mobility and the two billion poorest people in
the world who simply want to survive. In effect, supermarkets and
service stations are now competing for the same resources.

This year cars, not people, will claim most of the increase in world
grain consumption. The problem is simple: It takes a whole lot of
agricultural produce to create a modest amount of automotive fuel.

The
grain required to fill a 25-gallon SUV gas tank with ethanol, for
instance, could feed one person for a year. If today's entire U.S.
grain harvest were converted into fuel for cars, it would still satisfy
less than one-sixth of U.S. demand.

I think the key idea here is Opportunity Cost. If we just take the simple example above, lets try and guess at what 1 year of nutrition is worth. Fair enough we're probably talking a low-end corn heavy diet, but thats enough to save lives for some. As we remember an NGO's TV ad saying that for the price of a cup of coffee we could feed a child for a day, we could use a number of US$1/day for cost. This simple math would result in US$365 of opportunity cost is lost production. To be more conservative, even if we say just US$0.25 per day of lost value from food, we're still at a good US$90 in lost food production just for one tank of ethanol. Food for thought.

As a side note, fast forward a few years and what we really need is biotech to give us a nice "fuel plant" with its ethanol productive capacity maximized. (there's the idea for Monsanto (NYSE:MON)) Then maybe the fuel could be more cost competitive. Biotech could be oil's worst enemy one day.

Perhaps you've seen the recent movie (or at least seen ads for) Who Killed The Electric Car?, which from what I understand suggests a conspiracy to deny US drivers of a clean, efficient car. A few weeks ago, Ralph Bennett offered what appeared to be a pretty compelling rebuttal of the film's premise, and discussed some major reasons why the car was basically a non starter:

(Electric cars) have succeeded as purpose-built vehicles -- fork lifts, golf
carts, "city cars," airport shuttles and the like. But they have never
become the car for the open road, the
let's-drive-over-to-the-shore-for-the-weekend car.

Why?

Let's go over this one more time, class: Range. Range is the
problem. Electric cars do not have sufficient range to be the
practical, versatile, every day car most people want.

They don't have range because they operate on batteries --
those mysterious sealed devices that convert chemicals into stored
electrical energy. And batteries can't store enough energy to keep an
EV going more than 50 or 60 miles, or in rare cases (with experienced
drivers and the latest and very expensive nickel-metal-hydride battery
packs) 150 miles, before they have to be recharged.

Put it this way. I can drive my wife's big Lexus 55 miles on two
gallons (about 16 pounds) of gasoline that cost me six bucks. An
electric car like the one featured here
could travel the same distance by exhausting its 1000-pound battery
pack (lead-acid, costing $2000) which would then have to be recharged.
The recharging would take about four hours. I could replace the two
gallons of gasoline in about 30 seconds, but I wouldn't have to because
my wife's car can easily go another 450 highway cruising miles on a
tank of gas.

I have always been fascinated by electric cars. And I appreciate the
enthusiasm of EV partisans. But, frankly, I'm a little tired of hearing
people brag about heroic 120 or 200 mile trips in their EVs. And how
they only had to wait three or four hours before their batteries were
charged up enough to go another 100 miles, provided they kept a feather foot.

Sounds compelling, but again, not having seen the movie (it may have addressed this), I'll remain on the sidelines. Now a new Bay Area startup, Tesla Motors, is getting attention for selling an electric car. It's even been mentioned in tech blogs like SiliconBeat for having raised VC money from the Google guys. Certainly looks pretty sexy. So will the conspiracy to deny you a clean car be busted by idealist techies? Not likely. Here's some numbers on it:

If
gas costs $3/gallon, the per mile cost for a vehicle averaging 25 mpg
is 12 cents, so the electric vehicle saves less than ten cents per
mile. If we assume a 100,000 mile lifetime, that's less than ten
thousand dollars, which doesn't make up for much of the cost difference
between the electric car and a conventional vehicle.

The range
is sufficient for many people's needs, although not all. But a sports
car does not have to carry many passengers or much luggage, leaving
more space for batteries. That suggests that a sedan would either be
much heavier and more expensive or have a substantially shorter range.

So if this is the best a niche house like Tesla Motors can do, it certainly doesn't seem like a sinister cabal is standing in the way of electric car -- instead it looks like the biggest challenge remains the laws of physics.

If you've ever seen "Smartest Men In The Room", the Enron documentary, you know that one of the most damning parts is when it plays the audio recordings of Enron traders bragging about shutting down power in California, and causing a power outage. Art De Vany has a nice take on this, which rings true:

The traders at Enron developed an exaggerated sense of their own
importance (they were but a handful in a market of many traders) and
used silly Star Wars terminology to describe their trades. Simple
triangle arbitrage became "Death Star" and they had similarly
over-dramatic names for other very basic forms of arbitrage. The press
and lawyers for the State of California (remember when Gray Davis was
governor) emphasized these dramatic terms and the overly self-important
emails the traders exchanged with one another to make it all sound like
a powerful conspiracy.

It was nothing more than boys playing trading games in the same way
they might play video games. Harmless boasting and an inflated sense of
power. In reality, what they were doing was enhancing efficiency and
the trading operation hardly made a dime for Enron, just what one would
expect in an efficient market.

My only experience being a trader is from summers home during college, sitting in front of my Suretrade account, going back and forth on what were borderline penny stocks. Now if you'll recall, the late 90s were a really easy time to make money in the market, yet that didn't stop me and my friends (who were doing the same thing) from convincing ourselves that we were genius traders -- that we were like sharks smelling blood, or killers who left other traders in body bags. Stupid? Hell yeah. But this is the adrenaline rush from being in front of a trading screen and making money. Now imagine a 25-year old guy, who drives a sportscar in a room with 50 other trader; imagine the testosterone, and then listen to those tapes of Enron traders again. So while the tapes sound bad, they should be taken for what they are.

As an ingoramus this Stalwart just learned about some of the hot IPO's recently on the London Stock Exchange, I believe. These are in regards to new securities companies set up to buy carbon emmissions credits and then sell them for a profit. An example is that one can go into another country, help a factory reduce its emissions (which in turn generates credits), and then sell the credits to say European factories at a price which yields a profit. Carbon credits only apply for those under the Kyoto Protocol, so the US can watch from the sidelines.

European Union's fledgling greenhouse gas emissions trading market.
The price of a carbon credit, a permit to emit one tonne of carbon
dioxide, has swung wildly.

In the wake of the volatility, shares
in companies that specialise in trading carbon credits have been hit
hard. There are at least seven such companies on the Alternative
Investment Market in London, the main centre in Europe for carbon
credit trading.

"They all got hammered, and some fell off a cliff," said Tom Frost, analyst at Numis Securities.

Among
the seven companies on Aim, Trading Emissions has fallen about 16.5 per
cent since the start of the month to 126.5p. EcoSecurities, which was
trading at 278p in April, fell to nearly 160p on Monday before
rebounding to 182p. CamCo, which recently listed on Aim, was trading at
64.5p yesterday, down from 92p in late April. Even Climate Exchange, an
exchange for buying and selling carbon and thus a play on trading
volumes, fell from 345p in March to 277.5p this week.

We've just stepped into the carbon credits waters... hopefully will be back with more. Feel free to leave comments which could enlighten us. Already we hear talk about European companies roaming Asia in order to find Asian factories, and then help them generate carbon credits for a profit.

Let's not forget that oil demand has sharply adjusted to high prices in the past. Thus we shouldn't be surprised if it happens again.

An extended read today, from Clarksons shipping intelligence, sorry no link since the site requires a subscription. The article is "Oil Price- What Do You Do When You Don't Know?" by Dr. Martin Stopford at Clarksons, 31 March 2006, presented in full below.

Whatever you may think about economics in general, there is one economic "rule" which is hard to argue with and that is the demand curve. Change the price of a commodity and the demand for it changes too.

The Price is Right

Although the rule works for most commodities, over last few years it seems to have been assumed that oil is so essential, especially to the fast growing consumers in Asia, that the price does not really matter. Whilst that was not an issue in the 1990s, as oil prices have spiralled (see graph) the time has come to ask how these price increases will affect demand (note that the bars in the graph show the oil price in current dollars and the line the price deflated by the OECD price index).

The Price is Wrong (For Tankers)

When the price of oil leapt from $10/bbl to $35/bbl in 1979 nothing much happened for the first 18 months – nobody said a word about the impact on future demand. But in the next three years the crude oil trade fell by a third. Admittedly this was a special case because much of the fall was due to the substitution of coal for oil in power stations. That extreme fall would be difficult to repeat because most power stations already burn coal or gas. But there are other demand effects.

In real terms today’s $68/bbl is close to the 1979 peak and although not as dramatic as that price hike, the rise was steep and unexpected. After all, it is only five years since OPEC pledged its allegiance to the $22-25/bbl price band, and a range of long term oil price forecasts published last year still assumed an average oil price of $28/bbl in 2025.

New Vision

Today’s forward oil prices anticipate $60/bbl for the next three years. The explanation is the perception that upstream spare capacity is now virtually zero. But some areas are more vulnerable to this price change than others. In Europe, which accounts for 30% of seaborne crude imports, the oil price is heavily shielded by taxes. In the USA demand for gasoline, the dominant product, is very price inelastic in the short term (although after the 1970s price hikes Americans surprised the world by switching to sub-compact cars). So that suggests the main re-sponse will come from Asia.

It is ominous that after two years of high prices we are seeing signs of precisely that. In March the IEA marked down their forecast of 2006 oil demand growth from 1.78m b/d to 1.49m b/d, due to "persistently high oil product prices and increasing evidence of demand weakness in south-east Asia".

One Horse Race

So there you have it. The tanker industry's problem has always been that it only ships one commodity. Oil may be a necessity, but if the price rises even further to $80/bbl, demand will certainly suffer. Which is all very well, but the oil price could just as easily fall again, as it did in 1986. Well, tanker investment never was easy. Have a nice day.

Noting the IEA downward revision in oil demand quoted above, we also show a quick excerpt from a May 12th entry by Dr. Stopford, from another article at Clarksons:

The IEA has just revised down its oil demand growth forecast for 2006 to 1.25m bpd, due to "sustained high oil prices". That's the second month in a row. With oil trading at $70/bbl and not much spare capacity in the system, it may not be the last.

Thus in two months the IEA has gone from forecasting oil demand growth of 1.78m bpd, to down 30% at 1.25m bpd. Just a data point, put score one for oil price elasticity.

One of the common complaints I hear from noneconomists is, why
should the price of gasoline go up as soon as there is any news of a
disruption in oil flowing from somewhere like Nigeria, when the
gasoline in the pipeline and the station's tanks have already been
bought and paid for by the company at a lower price?

Why, indeed? The answer is, because if the price didn't spike up
immediately on the news, the result would be a disaster for the public.
I presume we can agree that the supply disruption will eventually mean
that the price will have to be higher and consumers are going to have
to make do with less gasoline. How should you as a consumer behave, if
the price did not go up today, but you know that in the future, you
might not be able to buy gas or will have to pay a much higher price
than you do today? The answer is, you should rush out and top off your
tank right now, while gas is still available and cheap.

Of course, when all your neighbors get the same idea that you had,
the result is a huge surge in the quantity of gas everybody is trying
to buy, which the system won't have the resources to deliver. Panic
buying by consumers would create shortages even if there had been no
disruption in supply.

Fortunately, it would not ever be in the personal financial
interests of gasoline station owners to allow this to happen. Why
should they run their tanks dry selling gas for $3.00 a gallon, if
there would be someone willing to pay them $3.50 for that same gas? A
station owner who was trying to maximize profits would never do this.
What we would expect to see in a properly functioning market is for the
price instantly to jump significantly above the value it will
be at next week. That creates an incentive for consumers to let their
tanks run a little lower right now rather than top them all off, which
is exactly what we need to see happen in order to deal with the crisis.

If you're a car-less New Yorker and don't have to deal with $3.00/gallon gas prices, it's reasonable to ask which is worse, high oil prices, or all of the attention paid to them? There's been so much rubbish from everyone, the press, The President, The Senate, O'Reilly, etc. that it almost seems like a hazard to turn on the television.

The President has no joined the shrill crowds who claim that America is addicted to oil. Addicted, as in alcoholism. Of course, our use of oil actually helps us accomplish things, unlike alcohol addiction. And while we may want to consume less of it, going cold turkey probably wouldn't be a wise idea. Were we addicted to oil back when, say, it was around $25/barrel? Were we addicted to oil back when Bush and Cheney were in the oil business? Were they peddling petrol just to feed an addiction? For shame.

I made the mistake of turning on The Factor, Friday night (stupid). Bill was yammering about how the government lacked the political muscle to mandate that all cars run on ethanol. Political muscle is one way to look at it -- constitutional authority is another one. The funny thing is, he concluded his bizarre and paranoid rants by encouraging Americans to boycott oil, which would bring the price down. He's right, it would; although what some call a "boycott" others would just call conservation. I'd like to see O'Reilly utter that word.

There's a lot of ranting to do right now, something we try to avoid on The 'Wart. However, I'll just say that I'm very much looking forward to the Summer, but not looking forward to The Summer Driving Season, the media's favorite term. People drive all year round, and energy prices aren't seasonal, so just stop already. Thanks.

If a stock adjusts down dramatically right before a big announcement can we chalk one up for market super-efficiency? Emerging markets tend to see a lot of this before bad news, which most label politely as "information-leakage".

Yesterday shares of NewMarket (NYSE:NEU) fell 12% on seemingly no news. Even the NYSE was stumped:

NewMarket Corp.'s unexplained 12.6 percent fall caused the New York Stock Exchange to ask the chemical holding company for more information late Monday.

The New York Stock Exchange said it asked NewMarket, whose operating subsidiaries make petroleum additives used in refining gasoline and other fuels, to issue a public statement "indicating whether there are any corporate developments which may explain the unusual activity." The Exchange said it made the request "in view of the unusual market activity in the company's stock."

The Richmond, Va., company stated its policy is not to comment on unusual market activity, the Exchange said.

Might market clairvoyance be an explanation? Perhaps there is something unseemly in the 1st quarter results, due out in two weeks.

The stock is down a further 5% pre-market. Interestingly, a director bought $4.7m of NEU shares at $42, right to where the stock fell yesterday (and now 5% above the current pre-market price). This was nevertheless a bold move seeing as how the stock has run up sharply in 2006. One final datapoint- the company has a US$50m stock buyback program in place which expires Dec 2007, announcd when the stock was near $25.

When results come out in two weeks we'll be able to see whether or not the market is weak-form clairvoyant.

What is This?

The Stalwart is a blog written by Joseph Weisenthal, covering such topics as stocks, business, economics, politics, technology, gambling, chess, poker, economics, current events, music, math, Chinese food, science, randomness, kurtosis, sports, evolutionary fitness, and anything else of the author's choosing. The words contained herein are the author's own, not affiliated with any other firm or employer.